Cryptocurrencies and African financial markets: integration, risk analysis, and diversification

Kumah, Seyram Pearl
Journal Title
Journal ISSN
Volume Title
The international financial system has witnessed cryptocurrencies as new financial instruments with increased growth in both volume and value and unique risk (return) benefits. The cryptocurrency market is integrating with financial markets which may induce increased investor participation with the chance of excessive liquidity in the cryptocurrency market. This can impair financial stability should there be shocks to the cryptocurrency markets. However, there is as yet little established scientific knowledge about the impact of cryptocurrencies on financial markets with African financial markets completely untouched. Such knowledge is critical since shocks to cryptocurrency markets may have rippling effects on the financial markets. The thesis contributes to fill this gap by investigating the nexus between cryptocurrencies and traditional asset classes in the African financial markets. This may help in understanding the microstructure of financial markets in general and the functioning of African markets in particular for regulating the general financial system. The thesis is organized into four empirical essays, each focusing on a research problem. The first essay examines the level of integration between cryptocurrencies and African stock markets using wavelet-based methods. Findings suggest low degrees of integration between the markets at higher frequencies, but this grows stronger at medium frequencies and perfectly integrates at lower frequencies. Implying that stock markets in Africa are highly exposed to cryptocurrency market disruptions from the medium-term and international investors seeking to hedge their price risk in African stock markets using cryptocurrencies may have to look at the short-term. The phase difference arrow vectors and cross-correlation analysis implying lead (lag) effects are time-varying and heterogeneous, showing no particular cryptocurrency or stock market as leader or follower. Different markets have the potential to lead or lag other markets at varying scales which may induce arbitrage opportunities for international and local investors. The second essay tests the ability of cryptocurrencies as viable alternatives to African fiat currencies during turbulent and tranquil currency conditions implementing the ensemble empirical mode decomposition-based quantile-in-quantile regression. The essay establishes that cryptocurrencies behave differently from African fiat currencies, showing significant negative relationship during extreme fiat currency regimes at medium and lower frequencies. This suggests cryptocurrencies as viable alternative digital currencies and good hedges for African fiat currencies form the medium-term. This essay affords policymakers in Africa and across the globe seeking for viable alternative digital currencies to mitigate currency crises to consider cryptocurrencies from the medium-term. Forex traders may also compensate for losses from currency shocks by using cryptocurrencies to hedge USD/African fiat currency exchange rate risk. In the third essay, we perform cryptocurrency market risk analysis focusing on tail risk and frequency spillover connectedness. The FZL function for joint Value-at-Risk and Expected Shortfall was used to measure tail risk, compare the level of risk, and capital adequacy of cryptocurrencies. Findings suggest Ethereum and Steller as less risky, followed by Monero, Das, Litecoin, Bitcoin, and Ripple, implying that Ethereum and Steller require the least capital to absorb losses. Investigating the time-varying interconnectedness across cryptocurrencies, the study posits that cryptocurrencies are strongely interconnected at high frequencies suggesting contagion risk in the cryptocurrency market and that diversification opportunity is low in the short-term. The essay also evidences time-varying volatility shock transmissions across cryptocurrencies. Economic actors interested in cryptocurrencies can follow this easy to hedge, calculate margins, and capital required to ensure financial stability in the global economy. The fourth essay sheds light on the hedging properties of seven cryptocurrencies (Bitcoin, Litecoin, Ethereum, Das, Ripple, Monero, and Steller) for gold and crude oil price fluctuations at bear (bull) markets across time employing wavelet-based quantile-in-quantile regression. The essay finds that cryptocurrencies provide negative dependences for extreme gold and crude oil price fluctuations from the medium-term, and that all cryptocurrencies are hedges for gold price fluctuations but only four cryptocurrencies (Ethereum, Monero, Ripple, and Steller) are hedges for crude oil price volatilities. The essay also evidences bidirectional causal effects among the assets establishing that when the cryptocurrency market is bearish and the price of gold and crude oil is low, economic actors can hedge the downside risk of the commodities or cryptocurrencies across time using either of the assets. The essay provides precise information to economic agents on risk mitigating strategies for gold and crude oil markets
A thesis submitted to the Faculty of Commerce, Law and Management, University of the Witwatersrand in fulfilment of the requirements for the degree of Doctor of Philosophy (PhD) in the field of Finance, 2021
SDG-8: Decent work and economic growth, Cryptocurrencie, Traditional Asset, Integration, Spillover, Time-varying, Africa